COMMENT: Ukrainian economy doing surprisingly well, but a crisis looms if IMF programme not restarted in September

The Ukrainian economy is growing at a healthy rate, but the situation could turn on a dime if the government fails to restart the IMF $17.5bn stand by programme in September.

By SP Advisors in KyivAugust 22, 2018

The Ukrainian economy is growing at a healthy rate, slightly ahead of analysts expectations. However, GDP growth will slow in 2019 as political uncertainty takes hold ahead of presidential and parliamentary elections next year.

Inflation has slowed on the back of a bumper harvest, but fundamental downside pressures are persisting, prompting the NBU to keep its monetary policy tight. The central bank has been forced to hike rates despite the cooling effect this has had on already lackluster growth.

The FX market has been turbulent in August and the hryvnia has dipped to close to UAH28 to the dollar. The absence of official external funding is a notable risk that could aggravate the situation rapidly in the coming months and a full blown currency crisis is possible in the autumn.

The return of the IMF and disbursement of a new loan tranche is critical for the economy to function smoothly through the end of 2019. The IMF mission will visit Ukraine in September and it’s hard to overestimate the importance of that visit.

GDP growth picked up to 3.6% y/y in Q2 (+0.9% q/q, seasonally adjusted), beating the market’s expectations. An early start to the harvest campaign and the resulting increase in crop production partially explains the pick-up.

The second quarter growth was broadly even across the economy, with trade (+ 5.7% y/y) the one outperformer that is consistently outpacing other key sectors. That robust trend is largely being driven by growing consumer and investment imports.

On the demand side, the growth is mainly supported by private household consumption. Rapid growth in nominal incomes (salaries grew 26% y/y in 1H18) and migrant remittances (estimated at more than +30% growth y/y in 1H) against decelerating inflation is fueling increased spending.

Consumer confidence is also improving – the GfK index rose 6.2 points y/y to 65.6 in June. Investment demand has remained robust as companies focus on maintenance capex after the 2014-16 crisis.

However, new greenfield investments will be limited given the substantial political uncertainty ahead of the March 2019 presidential election. SP Advisors have upgraded its 2018 GDP growth forecast to 3.4% y/y from 3.1% previously. However, in 2019, weaker consumer and investment spending will depress GDP growth to below 3%.

Another welcome development was inflation’s dip into single digits in the second quarter and will remain stable through the year-end. CPI slowed to 8.9% y/y in July, the lowest reading in almost two years as inflationary pressures have eased substantially in recent months.

Good weather conditions, in contrast to last year’s late frosts, have resulted in a bumper harvest, which in turn, has pushed food price growth down to 7.1% y/y. However, fundamental inflationary demand-side pressures are still material because of the high growth of salaries and other incomes.

The NBU’s tight approach to monetary policy (the regulator raised its key rate to 17.5% in mid-July) is gradually pushing commercial rates up. As a result, a larger proportion of incomes is flowing into deposit accounts rather than being spent on current consumption. Looking ahead, a possible increase in regulated gas prices could significantly contribute to inflation. SP Advisors maintain its end-2018 CPI forecast at 8.9%.

The risk to external accounts is minimal, as long as IMF cooperation restarts. Ukraine’s external accounts remain fairly balanced for now. The 12-month trailing C/A deficit remains just above 2% of GDP, substantially better than the historical average. The gap is still being covered by financial account inflows to the private sector.

The current level of the C/A gap looks sustainable, as the widening of the trade balance is being offset with larger migrant remittances. However, the financial account is at risk; a significant amount of state debt is to be redeemed in 2H18 and 2019, which could push the financial account into deficit and require a significant adjustment of the hryvnia exchange rate. With no external official funding available to Ukraine since 1H17, the authorities have used NBU reserves (-5.6% YTD) to repay sovereign debt. Recent FX market imbalances have resulted in a 5% depreciation of the hryvnia since the start of July. The prospects for the hryvnia exchange rate and broader FX market stability are largely dependent on Ukraine’s return to the IMF-backed reform path, which would unlock the next loan tranche.

September’s IMF mission represents Ukraine’s last chance to relaunch the stalled loan program. The current turbulence in the FX market, tolerable for now, combined with government liquidity pressures (both in hryvnia and foreign currency) are a signal that the situation could turn on a dime at any time through the end of 2018 if the IMF’s return is delayed.

The IMF mission will visit Ukraine in September, which could mean that a compromise on the contentious gas price deal is on the table. However, the risk is still substantial that the mission will not attain its goal. That would spell the end of the current IMF program.

The stakes for Ukraine are huge – the World Bank has reiterated that it will only provide its loans and guarantees to Ukraine if the IMF program is on track. The statement from the IMF visit in late September will be a key milestone to watch.

"Hasta la vista, Andy!" wrote Hungarian PM Viktor Orban to the former Hollywood producer who revived Hungary's film industry, but was criticised for his involvement in pro-government media.

2018 is now behind us and it was a painful year for most investors around the world, across all asset classes. In USD terms, MSCI indices for frontier and emerging markets ended the year with a negative total return of 16.4% and 14.5%

Cookies on the bne IntelliNews website

This site uses cookies - small text files that are placed on your machine to help the site provide a better user experience. In general, cookies are used to retain user preferences, store information for things like shopping carts, and provide anonymised tracking data to third party applications like Google Analytics.
As a rule, cookies will make your browsing experience better. However, you may prefer to disable cookies on this site and on others. The most effective way to do this is to disable cookies in your browser. We suggest consulting the Help section of your browser or taking a look at the About Cookies website which offers guidance for all modern browsers.

Recover password

Recover link have been
expired

Set new password

Access recover request have been expired.
Please, try again.

Complete registration
process

To continue viewing our content you need to complete
the registration process.

Please look for an email that was sent to
with the subject line
"Confirmation bne IntelliNews access". This email will have
instructions on how to complete registration
process. Please check in your "Junk" folder in
case this communication was misdirected in your
email system.